Monday, June 14, 2010

The Problem with the SEC Single Stock Circuit Breakers

A departure from the charts tonight as I rant against "more stupid government financial regulation supposedly to protect the little guy but instead will work against them."

The new SEC Circuit Breaker Rules require that a stock be stopped for 5 minutes if that stock has moved in price more than 10% in the preceding 5 minutes. This rule applies only to stocks in the S&P 500, during a trial period until December 10. It specifically does not apply to the ETF's that include these securities. I have been stating over the weekend that should these circuit breakers kick in, there will be a further advantage to the big investment banks and HFT's over us little guys. Let me use Citigroup, Ticker C, to illustrate my point. C is in the S&P 500, but it is also in the Dow Jones Industrial Average of 30 stocks. Note that there is an ETF based on the Dow 30, the DIA. C closed at 3.88 today so a 10% move would equal 39 cents.

Suppose at 10:30 tomorrow Moody's downgrades a bunch of South American sovereign debt unexpectedly and it is learned that C is a large owner. The stock price falls 40c in one minute. C is now halted for at least 5 minutes, but the DIA continues to trade lower pricing in a 60c move for C. Large investment bank's and HFT's (who are now busy programming their trading systems to look for these types of swings) have their systems sell the DIA as C hits the 10% limit and simultaneously buy all of the Dow 30 except C. They have now created a synthetic short position in C, so they continue to capture the downside. They can unwind their trade as soon as the synthetic C stops falling, to capturing the additional implied move down at anytime, or if it keeps falling when the stock reopens down 60c and capture the 20c additional down move. Us little guys, without the ability to simultaneously trade 30 stocks are left to ride the exposure down and hope for the best.

I used this example because it was simple to illustrate but think for a while and you can easily apply this to other scenarios: 11:00 Leak that Surgeon General is issuing a statement that Aluminum causes cancer (AA/DIA), 11:30 Chinese Government declares war by knocking out Verizon land and cell networks, (VZ/DIA). You get the picture, I am not really getting very creative here. Think about it.

I thought the SEC was supposed to protect investors.

Now back to the charts.

1 comment:

  1. Agreed Greg! The Government creates more issues by trying to fix some.